In recent months, European markets have staged an impressive run of outperformance relative to the United States. What began as a tactical move by investors to capitalize on valuation asymmetries has evolved into something more structural: a story increasingly underpinned by fundamentals. The policy tone across Europe has become more constructive, with a shift toward a more expansionary fiscal mindset raising hopes that the continent might finally unlock a stronger and more sustainable set of investment opportunities—something that has eluded investors over the past decade.
Yet, even as sentiment improves, there are reasons to temper the enthusiasm. While encouraging, the positive fiscal narrative in Germany is not representative of the broader European landscape. Growth upgrades elsewhere in Europe remain more modest, and fiscal headroom outside of Germany is far more limited. Should other countries attempt to follow Germany’s lead, they could be increasingly exposed to rising borrowing costs. At the same time, with much of the good news already priced in, European risk assets are now more vulnerable to a range of near-term headwinds—from the risk of reciprocal U.S. import tariffs to the prospect of a deeper-than-expected slowdown in the U.S. economy, which would weigh heavily on Europe’s externally oriented growth model.
Here are seven reasons why, despite Europe’s recent resurgence, the core elements of U.S. market exceptionalism remain intact—and why the balance of global leadership in growth, innovation, and market dynamism continues to favor the United States.
1. Valuation asymmetry is no longer firmly in Europe’s favor
At the turn of the year, European valuations were flagging as very cheap relative to their own history. Indeed, since 2003, MSCI Germany had been cheaper 66% of the time, while MSCI US had been cheaper 98% of the time. This valuation asymmetry was one of the strongest arguments for investors turning their attention away from the U.S. toward international markets, including Europe.
Fast forward to late February, and after a tremendous market rally, European valuation metrics now appear expensive compared to their own history. In fact, MSCI Europe has traded at cheaper levels 90% of the time – no different to the U.S., where after the recent pullback, is also trading at a valuation level that is 90% more expensive than its own history.
As such, the valuation argument for investing in Europe has significantly dimmed, and a meaningful improvement in European fundamentals will be required to continue driving strong outperformance. (It is worth noting that Europe only looks expensive compared to its own history – compared to the U.S., European valuations continue to screen as attractive.)
2. Germany is not Europe
The upgrade to Germany’s medium-term forecasts is quite meaningful amid a potential for a boost to the long-term GDP growth rate if the newly relaxed fiscal approach inspires deep structural reforms. However, given the limited fiscal capacity of other EU countries, the shift in Germany’s fiscal stance is unlikely to be replicated in other Euro-area countries. Put simply, the economic impact on the broader Euro area is likely to be considerably smaller than it is in Germany.
While the general direction of travel is positive for the Euro area, ultimately, the boost to Germany’s earnings outlook and, therefore, Germany’s investment outlook, is a more compelling investment case than the broader Euro area.
3. The threats of a further European debt sell-off
It is important to distinguish Germany’s fiscal situation from that of the rest of the Euro area. The dramatic shift in Germany’s fiscal stance has led to a sharp sell-off in German bunds, which has also pushed up sovereign yields across Europe. While Germany can likely afford the rise in borrowing costs (years of austerity have left its public finances in strong shape), most other European countries have significantly less fiscal headroom, and are therefore vulnerable to higher financing costs.
In fact, if a country such as France, which has seen its debt load balloon in recent years, chose to increase defense spending, it would need to ward off the circling bond vigilantes by offsetting the extra expenditure, either by lowering spending elsewhere or raising taxes, in turn weighing on growth prospects. Germany’s decision to increase fiscal spending may actually end up becoming a negative force for other European countries who are not in as solid of a fiscal position.
4. U.S. tariffs are coming
In the early part of the year, European markets received a boost as President Trump failed to announce an increase in import tariffs on Europe. However, the tariff threat has by no means passed. On April 2, the U.S. administration is set to announce its policy of "reciprocal tariffs.” With its large trade surplus with the U.S. and higher tariffs in several sectors, as well as a 20% VAT rate across all member countries, Europe is particularly vulnerable.
We estimate that a 10% tariff across all EU products would hit EU growth by 0.4%. The impact steadily increases with higher tariffs and, in the worst-case scenario of a 25% blanket tariff, EU growth would be lowered by 1.1% - potentially plunging Europe into recession this year.
5. A potential U.S. recession is a risk to Europe’s outlook
In reality, it is more likely that U.S. tariffs will be targeted at specific sectors and industries rather than applied uniformly. Either way, tariffs have the potential to fully offset the positive impacts from Germany’s fiscal package. Indeed, with newly announced auto tariffs likely to have a significant negative impact on Germany this year, tariffs threaten to overturn the impression of a more positive fundamental outlook.
Our baseline scenario is for the U.S. economy to slow quite significantly in 2025, but to skirt recession. Yet, if recession fears become more acute a decoupling between the U.S. and Europe (and other global markets) is unlikely. Historically, when the U.S. market suffers a drawdown of 10% or more, other international markets fall too.
However, history also shows that relative performance varies, with U.S. outperformance not a consistent picture. As such, it is possible that Germany’s reflationary shift could prevent Europe from suffering a relatively deeper pullback, in the event of U.S. recession in 2025.
6. U.S. deregulation is a tailwind tough to match
The U.S. has pursued deregulation for years, fostering innovation, reducing business costs, and boosting economic growth. In contrast, Europe's complex regulatory framework and excessive reporting obligations are seen as major barriers to innovation and growth. Indeed, European businesses have long complained about their struggles with red tape and bureaucracy, hindering global competitiveness.
According to the Financial Times, between 2019 and 2024, the EU produced 13,942 legal acts, while the U.S. produced just 3,725 pieces of legislation and passed 2,202 resolutions. The current Trump administration aims to push deregulation even further, removing 10 regulatory rules for each new one, further widening the gap with the EU.
Notably, during a recent trip to Madrid, investors expressed to me their strong view that deregulation, not fiscal expansion, is the key to stronger economic growth in Europe.
Reducing bureaucratic burdens and fostering competition could make Europe a more attractive investment destination, unlocking the potential for European outperformance. At the same time, however, the European investor community remains very skeptical about Europe's willingness to deregulate. They view the deregulation disparity between the U.S. and Europe as likely to persist, offsetting the positive impact from Europe’s more expansionary fiscal approach, and ensuing that the U.S. continues to demonstrate superior economic growth prospects over the next decade.
7. U.S. exceptionalism features still in play
For a near 15-year period since the financial crisis the U.S. consistently outperformed other equity markets on the back of much stronger profit growth, greater innovation and productivity growth, and major global influence – and the technology sector sits squarely at the center of those themes.
Although the U.S. tech sector is currently under pressure as investors rethink lofty earnings expectations and capex spending, this may prove temporary. The U.S. remains at the helm of technological advancement and innovation, with AI-driven productivity gains set to benefit a wide range of sectors and companies. So, despite the recent turn in investor sentiment hitting the Magnificent Seven, earnings growth potential from key U.S. tech players remains strong and likely to continue contributing significantly to overall earnings growth over the coming years – suggesting a key driver of U.S. exceptionalism is likely down, but not out.
Another key factor contributing to U.S. exceptionalism is the strength of the U.S. dollar and its role as the world’s reserve currency – enabling the U.S. more flexibility in both monetary and fiscal policy. For its status to truly weaken, the greenback would need to enter a prolonged period of decline. While some argue that the USD is now in secular decline, pointing at America’s rising debt levels, political divisions, and growing unease over U.S. geopolitical strategies, the reality is that no clear alternative currency has emerged.
The dollar remains firmly in place for now, but there are several future challengers on the horizon. A more productive, fiscally united Europe could strengthen the euro’s global role, while a more balanced, resilient economy in China could lift the renminbi’s standing. Even Bitcoin, with its decentralized structure and global accessibility, has been touted as an alternative to the U.S. dollar. But for the time being, the U.S. still holds a position of strength.
